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Friday, 4 November 2011

Royal Basketcase of Scotland

Much fanfare from the hacks as RBS reports a Q3 profit of £2 billion compared with a £1.3 billion loss same time last year, but a quick perusal of the numbers shows that all is not as rosy as they make out.

The top line shows £6.3 billion of revenues followed by £3.5 billion of operating costs, which sounds respectable until you realise that banks have a whole lot of impairment items that I would have called part of the operating costs of banking, but I am not an accountant.

First up is £700 million of net insurance claims - i.e. a loss making insurance business.  Now I don't know much about accounting for insurance companies, but I would have thought that paying out on isurance claims was really a sort of operating cost for insurance companies - the flip side of receiving all that premium revenue, which I assume shows up in the £6.3 billion of revenues, but maybe not.  Anyway, this gives RBS an operating profit of around £2 billion.

But hang on they then add in £900 million of impairment losses which brings their "core" Operating Profit (with a capital O and a capital P) down to £1.2 billion, and then they add in another £1 billion of "non-core" operating losses which brings their Group Operating Profit to a measly £200 million or so. A billion is still quite a big number, and to have a billion of losses seems pretty core to me when that amounts to 16% of your top line revenue.

But it gets worse than that.  For some reason that is not entirely clear, the directors of RBS have decided that impairments on sovereign assets are not the same as impairments on ordinary paper, so there is another £140 million of losses that aren't included in the Group Operating Profit, and then there is a payment of £60 million to the government for the Asset Protection Scheme.  That sounds rather like an insurance premium to me, so I fail to see why that isn't included as a normal operating expense.

Oh and then we have another £418 million of "Other Item" losses.  Have you ever noticed how the losses are always extraneous to the business, but the revenues are where the directors are focussing their attention?  Perhaps if they paid more attention, the shareholders (tax payers) wouldn't have to pay for the £2.5 billion of non-core losses that popped up in the three months - about £42 million for each working day.

So at this point RBS is in a £350 million hole, so where does the magnificent £2.004 billion pre tax profit come from?

From our old friend "Fair value of own debt".  In other words the credit standing of RBS relative to the rest of the market fell by so much in the quarter that the mark to market value in the hhands of the debtholders of the securities that the bank had already issued fell by £2.3 billion.  By one of the most ungodly accounting wheezes know to man, RBS get to book that bit of bad fortune as profit.  If that sounds like good news, then remember that the discount/gain will simply be reflected in future higher interest costs as the borrowings are repaid upto maturity than would have been incurred if the paper had not been marked to market. So understand this, nothing happened and nothing will change in the future with this debt, but because of changes in market rates, and without doing anything themselves, RBS get to show a £2.36 billion profit now and will record £2.36 billion more interest costs in later years.

That's right: 115% of RBS' Q3 profits have actually been made by bringing forward income from future periods and increasing future costs by the same amount.

Details here:


Jive Lad said...

Alex, forgive my ignorance, but aren;t banks subject to standard regulations on accounting and how they present their results. Of course, we have all heard of 'creative' accounting, but this seems beyond the wildest creations of Dali, Pollock with a hint of Rothko.

If it is so easy anyway (as you ave shown) to depict the 'real' situation then why do they indulge in such shennanigans?

Alex said...

This isn't really creative accounting (see Enron for that), but merely conjuring, as in "Here is a number I want you to focus on. Don't worry about that number it isn't very important although I will disclose it to you to give you the whole picture".

My favourite, or least favourite, is EBITDA, a widely used term intended to give a measure of operating performance. It stands for Earnings Before Interest Taxes Depreciation and Amortisation (in other words before taking into account most of the things that helped to produce the earnings.

Why do they do it? PR, and a wish to make themselves look good (pay, preferment, bonuses etc). The usual stuff.